Dirham exchange rate issues

The explosion in overseas investment in Dubai would appear to have fallen dramatically over the last few months although many investors are set to pay the price for chasing the Dubai property market higher and higher over the last two years. International investors are set to experience a “double whammy” as both property prices continue to fall and the exchange rate moves against them. This has the potential makings of a disastrous nightmare scenario for many international investors who had high hopes of significant profits.

Payment structure for international investors

As the Dubai property market is still fairly mature in international terms there have been a significant number of new developments over the last few years which many property investors have snapped up. These projects can take some time to complete and with payment structures generally equating to a 20% payment upfront, 30% stage payment and then a final 50% towards the end, many investors do not seem to appreciate the potential currency risk which these payment structures can offer.

In some cases it can be up to 2 years before the final payment is due and while historically you would not expect a major shift in exchange rates, we are not dealing in normal markets!

The Dirham v Sterling

It has never been more vital for international property investors, and international investors on the whole, to ensure they keep a very close eye on exchange rates which could affect their investments in the short, medium and longer term. A quick glimpse back at the Dirham v Sterling exchange rate shows that Sterling was converting at 7.15 Dirhams back in August 2008 and recently hit a new low or 4.99 Dirhams in January this year (a fall of 30% for Sterling investors). The current rate is roughly around 5.2 but this is still a significant reduction on the 7.15 only a few months ago.

While sterling has seen a small improvement over the last couple of weeks there are serious concerns that UK base rates are set to fall again (by as much as half of one percent today) to a new low of one percent. However, many economic experts fully expect the Bank of England to reduce UK base rates to around 0% in a last-ditch attempt to refloat the UK economy and increase liquidity in the money markets. If this was the case, it is highly likely that sterling will encounter serious selling pressure in the weeks and months ahead.

The impact on the Dubai property market

Those who follow the Dubai property market closely will already be aware that the markets have pulled back significantly from recent highs and liquidity in the money markets is markedly lower. As a consequence, property prices across the board have fallen substantially and many of the newer and unfinished developments have literally been dumped onto the market by struggling property developers, many of whom are on the brink of potential bankruptcy. Indeed, we recently saw a significant number of job cuts among some of the major Dubai property developers which does not bode well for the future.

While a large part of the increase in the Dubai property market was down to international investors looking for a new home for their money and the potential for significant capital growth, there are serious concerns that while some international property investors have already left the market there are many unaware of the potential currency risk they have taken on. When you consider that some international investors will already be nursing a 30% increase in the cost of their property purchase, purely because of the exchange rate, it is likely a significant number will be forced to default on their initial contracts.

While generally a property developer is able to withhold 30% of funds paid upon the default of a purchase contract, this may well offer investors an alternative to further losses in the future but will no doubt see yet more property assets for sale at potentially distressed prices. This is sure to drag down the overall market as the number of international investors unable to honour their original contracts could be significant over the coming months.

More worryingly, many international investors who “jumped onto the Dubai property bandwagon” may not even be aware of the substantial increase in their potential payments until they are due. This perfectly illustrates how property “hot spots” can often attract inexperienced property investors desperate to make money but often unaware of the potential short-term, medium term and long term risks.

Reducing your currency risk

As mentioned on the thread at the Property Community forum, many international property companies tend to reduce the potential risk of currency movements by acquiring up to 30% of the overall cost of any project in the relevant currency at day one. The fact that investors are able to buy “forward” any currency in the world also offers the opportunity to finalise the overall cost of any development from day one by simply exchanging the full amount from their domestic currency into their investment currency.

However, there are still substantial risks bearing in mind that many investors will at some stage look to liquidate their international investments and convert back into their local currency. In all honesty, those who invest in international property markets, and international markets in general, where there is any exchange rate requirement will be opening themselves up to currency movements in the short, medium and longer term.

Conclusion

While domestic investors in the Dubai property market are currently nursing substantial reductions in the value of their property assets the situation looks set to get much worse for investors based in countries such as the UK, with sterling having fallen sharply on international currency exchange markets. This double whammy for international investors could see a number of property purchase contracts broken or contracts honoured and substantial losses taken on board from day one. Either way it looks certain that there will be a constant flow of distressed price property sales appearing on the Dubai property market have some time to come.

While the substantial devaluation of the pound has caught many unawares, even though we are not trading in traditional markets, international investors should be aware that as well as asset risk they will also be exposing themselves to currency risk in many situations. A great number of UK investors will experience a nasty surprise over the weeks, months and years to come as they receive demands for future instalments of their property purchase agreements. This should be a lesson to all, do your homework and be aware of all potential risks involved!